Last week the Short & Simple Investment Lesson was about the different types of performance measurement terms. You may recall that this is just lingo for measuring the different ways that your money works for you, and the names given to each of those methods. Today let’s look at how a pair of new black boots relates to Return on Investment, or ROI, one of the most common investment performance terms.
You can apply this handy little tool to anything in your life, as well as your investments and your business. You know I like clothes, so let’s use a pair of black boots that are on sale at your favorite retailer for $129, including tax. When you spot those irresistible black boots on the sale rack, the thought process goes something like this…Ok, I am going to spend $129 of my money to buy these boots, so what will I get out of that investment? Will I wear them? Are they comfortable? Will they fit into my existing wardrobe? How many times will I wear them? How many years will they be in style? You are reviewing in your mind the return you will get from your investment in these boots. From this, you calculate if the return you will get from the boots is worth the $129 you have to spend to own them. The return on investment from the boots comes in the form of comfort, style, wear ability, and duration, to name only a few benefits.
In the same way that you looked at the amount of money you had to put into owning the boots and measured the return you would get from them, you measure the return you can get from an investment. Just like the boots may turn out to be less comfortable than you thought when you bought them so you don’t get your original expected return, the investment may not go as well as you thought it would. Like the boots, investment ROI is based on the probability of the benefits you will get from owning that investment. Actual performance numbers are used to measure the results of owning the investment instead of less specific benefits, so it is actually easier to calculate the ROI from an investment than those black boots.
More specifically, the return on an investment is the difference between the amount you put into an investment and the amount you receive at the end of the investment. With investments, ROI is a common term and it is expressed as a percentage of your original investment. If you put $10,000 into an investment for 1 year and at the end of the year you got back $11,000, you would have earned $ 1,000 on that investment. The ROI would be 10%, calculated as $1,000/$10,000.
The bottom line is this; if you can measure the ROI on a pair of black boots, you can certainly do it on any investment you are considering, whether that means putting money into a money market account at the bank or buying into a stock index fund. Always look at the return you can reasonably expect from any investment you are considering. This is one of the many topics I’ll be covering during the year at the Financial Woman Alliance for investment education. A financial woman always calculates what her expected Return on Investment is before making an investment, whether she is spending her money on a pair of black boots or an investing in a stock fund.